Legal Structure Questions

[Jennifer Taylor]

Hi everyone, 

I'm looking for any legal references that can help me answer the following questions and provide guidance as to whether this approach is sound or needs adjustments: 

-What is the entity structure for managing assets and activities of a short/mid-term rental business? We currently have a LLC that owns our existing rental property and we run the short term rental activities through this LLC with its own separate bank account.

-We are closing on a primary residence in a couple of weeks that has a cottage on it that we will begin short/mid term renting upon close. My thought is that we open a new LLC to run all property management activities (for existing rental property and cottage) along with new bank account, etc. for all activities. The existing rental property will continue to be owned by the existing LLC. The cottage property will be held by us personally as it will be located on our primary residence property.

-I will then put in place a lease agreement between ourselves personally to the new property management LLC to lease the cottage and between the ownership entity of the other rental property to the prop management company. We will also have a short/mid term lease agreement put together for renting out these rental properties with an intention to further limit liability.

My overall question is whether this structure is sound or if we should take a different approach to limit liability. Additionally, if we open a LLC to manage our own properties, do I need to hold a broker's license in KY to do this legally? I am a licensed agent in State of CA but have not taken steps to also get it here.

If anyone has experience in this or has a referral to a legal firm who can help with this I'd appreciate it.

Thanks y'all!

Jenny

[Stuart Udis]

@Jennifer Taylor First  answer this: Do you currently operate your properties with all proper permits and licenses? Do you plan to obtain all necessary permits and licenses for future work that’s required? Do you maintain the correct types of insurance and adequate amounts of  insurance? Do you use licensed and insured contractors? Are you listed as additional insured under their policies? Do you require contracts with indemnification language, payment schedules and appropriate warranties?  Do you obtain lien waivers? Are you active or do you have a PM who is actively touring your properties to prevent or eliminate premises liability exposure?  

If the answer to any of these questions is no, not consistently or not well,  you should start by addressing  these operational issues in your business. Too many in your shoes focus all of their time and energy on preparing for the liability event and fail to address the items in their day to day business that can actually prevent liability exposure. Also the investor  who makes a conscientious effort to do these items is in most cases more prepared for when the liability event does occur. 

I also believe your management LLC is overkill if liability protection is the intention. Perhaps it may help with accounting/book keeping but it will not protect against claims. Neither will leasing the cottage to an LLC as an intermediary. If anything you will add additional expenses because you will want general liability and perhaps even E&O insurance for the management LLC. It's also commonly referred to as an Alter Ego in legal jargon and often times actually complicates litigation if a claim arises. There's probably asset protection specialists/firms who will side with your approach but it's not practical and they are just fee collectors.

[Jennifer Taylor]

Thank you, @Stuart Udis  I would say we are very risk averse and so the the answer to the operational questions posed is a yes. 

In the absence of another LLC this would assume running activities through our existing investment entity. If just going this path is more practical it would simplify things significantly, but everything I understand says introducing these new activities and the respective liability could expose our other property to risk if a nuclear claim occurred related to either property if they were part of the same LLC.

[Stuart Udis]

The part you are missing is if that claim were to arise why wouldn't the plaintiffs attorney simply list the deed holder in the claim? There's nothing you can do to prevent that from occurring and it's quite frankly the first defendant most plaintiffs attorneys will think to include. They can add the management LLC as well. If you're doing everything correctly as it seems you should be fine and again there's nothing wrong with adding the management LLC but don't expect additional liability protection as a result.

It seems the most likely issue is simply having your personal names as the deed holder listed in a complaint although again, based on what you shared about your sound operations your insurance should cover any claims that would arise since you wouldn't be triggering any coverage exclusions. It's one of the downfalls of renting properties in your personal names. You could purchase the property in an LLC or perhaps subdivide the cottage residence and own that in the LLC that owns your other rental property but not sure how that would impact your financing and how practical that subdivision would be?

It's normally the fear of being listed as a defendant in a complaint and not the actual taking of assets that leads to this discussion we are having , although not articulated well. Meanwhile our litigation system favors seeking cooperation from insurance carriers but that in itself is a whole other subject. 

[Chris Seveney]

Quote from @Jennifer Taylor:

Thank you, @Stuart Udis  I would say we are very risk averse and so the the answer to the operational questions posed is a yes. 

In the absence of another LLC this would assume running activities through our existing investment entity. If just going this path is more practical it would simplify things significantly, but everything I understand says introducing these new activities and the respective liability could expose our other property to risk if a nuclear claim occurred related to either property if they were part of the same LLC.

 This is what insurance is for. can you think of a reason why someone could file a lawsuit where your insurance would not cover you?

[Drew Sygit]

How are you going to deduct mortgage interest, depreciation, property taxes, insurance, etc on the cottage tied to your primary home - without getting flagged for an IRS audit?

Everything else you can just get insurance for protection.

[Ashish Acharya]

@Jennifer Taylor Your structure looks solid, but here are key considerations:

1. LLCs: Keeping each property in a separate LLC is good for liability protection. You can keep the cottage in your personal name, but a separate LLC could add more protection. This will have no tax savings.
2. Property Management LLC: Managing both properties through a new LLC is fine, but ensure formal lease agreements between yourself and the LLC are well-defined to maintain liability protection. This can give you some tax saving that needs to be discussed with your CPA.
3. Broker’s License: In Kentucky, managing your own properties typically doesn't require a broker's license. Double-check local regulations, but you’re likely fine without one.

This post does not create a CPA-Client relationship. The information contained in this post is not to be relied upon. Readers should seek professional advice.